BEIJING, China - Like a boxer slimming down for a fight, Li Zhongjian is shrinking his 20-year-old business manufacturing cigarette lighters to brace for a credit crunch he sees looming over China's entrepreneurs.

Li's workforce in the southeastern city of Wenzhou has shrunk by half to 300 this year and he isn't replacing employees who leave. He said he used to borrow money but is preparing to do without credit that might no longer be available as regulators try to force Chinese banks to cool a lending boom they worry could race out of control.

"The authorities' shifting policies are not offering stable surroundings for businesspeople to be confident to work," said Li. "I won't try to get loans for my business any more. I'll wait and see how the market and policies are doing. I won't invest, either."

A cash shortage that hit China's credit markets this month was the first shock wave from what analysts say could be Beijing's most drastic clampdown on credit in two decades. The central bank has called for tighter lending standards, which should reduce risk but is likely to reduce financing for a private sector that generates China's new jobs and wealth.

China will benefit in the long run from a safer financial system, but the short-term cost could be a painful squeeze on entrepreneurs. Some say a recovery that already was faltering could weaken further.

"It's going to be a bloodbath," said Anne Stevenson-Yang, research director of J Capital Research in Beijing.

"Rates are shooting up in the private market and regular commercial loans are being pulled back very quickly," she said. "All industrial businesses here run on credit, so as soon as you close that down, they just stop producing and selling stuff."

The government has yet to say how extensive the controls will be or what it might do to ensure lending for producers who Chinese leaders have said they want to support.

Some branches of two of China's biggest lenders — Bank of China and Industrial and Commercial Bank of China — have temporarily suspended lending to businesses and individuals, the business magazine Caixin reported, citing sources at the banks.

The credit clampdown hits amid uncertainty about whether China's lacklustre recovery from its deepest downturn since the 2008 global crisis is stalling.

Economic growth decelerated to 7.7 per cent in the first quarter from 7.9 per cent the previous quarter. May retail sales fell short of forecasts and export growth slowed. An HSBC Corp. survey of manufacturers showed June activity fell to a nine-month low and was contracting.

Tighter credit controls could cause growth to dip below 7 per cent in coming quarters, according to Nomura economist Zhiwei Zhang. That would be China's weakest performance since the early 1990s.

Harder times for Chinese entrepreneurs could have global repercussions. China's slowdown already is depressing demand for iron ore, copper and other commodities, crimping the flood of money that drove a boom for Australia, Brazil and other suppliers. Demand for industrial components from Southeast Asia and factory equipment from the United States and Europe could be hurt if credit-starved manufacturers put off purchases.

The crackdown is part of a broader effort by communist leaders to shift China to slower, more sustainable growth based on domestic consumption after a decade of explosive expansion driven by exports, investment and cheap credit. The ruling party's growth target this year is 7.5 per cent, down by almost half from 2007's staggering 14.2 per cent.

"The episode is arguably the strongest sign yet that the leadership is willing to suffer short-term economic pain if necessary to achieve more sustainable growth," said Capital Economics analyst Mark Williams in a report.

A key goal appears to be to force banks to reduce their role in channeling money into unregulated, profitable and risky underground lending that is a pillar of support for entrepreneurs who cannot get formal loans from state banks.

Money for informal lending came at first from individuals who wanted a better return on their savings but much of it now comes from state banks. They hid the lending from regulators, who worry they have taken on undisclosed risks in the event of defaults.

Even before the credit squeeze, underground borrowers paid interest of up to 70 per cent a year — more than 10 times the benchmark rate for formal loans. Estimates of outstanding loans run as high as 4 trillion yuan ($650 billion), or as much as 7 per cent of China's total credit.

Li, the entrepreneur in Wenzhou, said he borrowed from both state banks and informal lenders to expand his business. He said he paid 6 to 14 per cent in annual interest for bank loans and up to 70 per cent for underground loans.

"Is it possible to find any country whose interest rate is higher than China?" he said.

Communist leaders allowed informal lending to grow over the past decade to support entrepreneurs. But regulators began to worry after the 2008 global crisis when they found banks were putting their own money into informal lending, taking on unreported higher risks.

Money flowed to entrepreneurs to pay for equipment and raw materials but it also flooded into speculation in stocks and real estate. Regulators ordered banks to tighten lending standards but worried credit still was growing too fast.

The squeeze on China's credit markets hit after banks that quickly expanded lending this year tried to replenish their resources by borrowing from institutions that had more cash.

Analysts say bankers expected the People's Bank of China to inject extra money into that interbank market. But the central bank refused to play lender of last resort, causing a credit shortage. Interest paid by banks for an overnight loan spiked from the normal 2-3 per cent to a record 13.4 per cent. That ignited fears China might face a credit crisis and caused stock prices to tumble.

Some analysts said the central bank is partly to blame because it failed to make clear how tough its stance would be.

Its behaviour was "extraordinarily reckless," said Williams in his report.

On Monday, the central bank blamed commercial lenders and told them to do a better job of forecasting funding needs. The official Xinhua News Agency accused banks of taking on extra risk by diverting money into speculation and unreported lending.

"It is not that there is no money but that the money is being put in the wrong place," Xinhua said in a commentary.

On Tuesday, the central bank eased off, promising "liquidity support" to banks that run short of cash.

Still, the central bank told commercial lenders again to cut back on risky practices, which will mean less credit for borrowers outside the circle of politically favoured state companies.

"Small and medium-size business will take the pressure of this credit crunch, that is for sure," said Yin Jianfeng, deputy director of the finance research centre at the Chinese Academy of Social Sciences, a government think-tank .

Many Chinese entrepreneurs have learned to live without credit. That has made them flexible and resilient but reformers say it has held back growth of private industry Beijing needs to encourage if China's growth is to stay strong.

Elsewhere in the financial system, regulators also are cracking down on other sources of financing.

Rural credit co-operatives have been ordered to review use of promisory notes, which are meant for small transactions but are being used by banks to hide loans, Caixin said this month. It said lending using promisory notes, which don't count against a bank's government-imposed credit limit, quadrupled last year to 1.2 trillion yuan ($200 billion).

The government is taking action in part because economic planners see diminishing returns from new investments.

Bank lending surged in the first three months of the year even as economic growth decelerated. Analysts said that suggested a big share of lending went to pay off other loans or trading stocks, real estate and other assets instead of industrial investment.

Total credit compared to annual economic output has risen by 50 percentage points to 210 per cent since the 2008 global crisis, according to UBS economist Tao Wang.

The underground lending industry was battered by the slump in global demand in 2010. That caused a wave of business failures and defaults, prompting protests in some areas and making savers wary of lending.

Chinese leaders have promised repeatedly to have state banks lend more to the private sector. But most loans still go to state enterprises that have close ties with banks and influential officials. Entrepreneurs say it is no easier to get a loan.

The promise of more lending "is only an aspiration," said Yin, the CASS researcher. "If nothing changes in the system, the difficulty of financing the private sector will remain unresolved."